Abstract This paper reports the results of a study designed to investigate the long-term reactions of investors to changes in the taxation of capital gains imposed by the 1981 and 1986 tax acts. Trading volume patterns are analyzed for portfolios of depreciated and appreciated stocks. The results are generally consistent with expectations based on a tax-induced model of investor trading behavior. Specifically, the results indicate that the 1981 tax act, which decreased the tax cost of selling appreciated securities by reducing the maximum tax rate applicable to long-term capital gains, was followed by a sustained increase in trading volume for those stocks. The 1981 tax act increased the tax cost of selling loss stocks. After a period of adjustment following the enactment date, loss-stock trading volume declined. In contrast, the 1986 tax act decreased the cost of selling depreciated securities and appears to have stimulated trading volume in those securities over a sustained period. The impact on trading volume for gain stocks, however, appears to have been limited to a short-term reaction during the latter part of 1986.
Ricketts et al. (Sat,) studied this question.